In a development that has an all-too-familiar feel, on Friday March 10, 2023, banking regulators closed California-based Silicon Valley Bank (SVB), in what is the second-largest banking failure in U.S. history. The closure of the country’s 16th largest bank has sent shivers through the financial sector, raising questions about other lending institutions. For those of us in the D&O insurance industry, the bank’s closure also raises unpleasant memories about past failed bank D&O claims. As discussed below, the sequence of events at SVB shows how rising interest rates represent a significant threat that could contribute to a combination of circumstances that might well lead to D&O claims. A copy of the FDIC’s March 10, 2023, press release announcing the bank’s closure and the agency’s appointment as the bank’s receiver can be found here.
EDITOR’S NOTE: I wrote and published this post earlier in the day on Sunday, March 12, 2023, and before the joint statement by the FDIC, the Federal Reserve Board and the Department of Treasury that the U.S. government will “fully protects all depositors” and that all depositors will be able to access all of their deposits on Monday, March 13, 2023. I also wrote this post before the Federal Reserve’s separate statement on the evening of March 12, 2023 that the Fed had created a Bank Term Funding Program designed to ensure that banking institutions had sufficient liquidity to “meet the needs of all their depositors.” This late developments on Sunday obviously shed a great deal of additional light on many of the topics discussed below; I have not attempted to go back and re-write the post in light of these developments. To the extent relevant, I may comment further tomorrow (Monday) on these developments, as well as on the way things go on Monday when it is time for the banks to re-open.
SVB, based on Santa Clara, California, was a go-to financial institution for the tech industry including many startups. Its fortunes have risen with those of the tech sector. As the tech sector enjoyed surging growth during the pandemic, SVB grew along with it. Deposits at the bank grew from $49 billion at the end of 2020 to the over $171 billion at the end of 2022. With assets of $209 billion as of December 31, 2022, SVB was the country’s 16th largest bank.
As customer deposits at the bank swelled in recent years, the bank put a large share of the deposited funds into long-dated Treasury bonds and mortgage bonds, a safe and sensible approach at a time when interest rates were low. However, in March 2022, the Fed began raising its federal funds target interest rate. As interest rates continued to rise in subsequent months, the value of SVB’s bond holdings declined (the longer-dated bonds lost value as higher interest rate instruments became available).
The real trouble for SVB started last Wednesday, March 8, when a rise in depositor withdrawal demands caused the bank to sell its entire available-for-sale investment portfolio, at a loss for the bank of $1.8 billion; the bank also announced its plans to shore up its balance sheet and raise $1.75 billion through public offerings of securities. In response to these moves, Moody’s on March 8 announced that it was downgrading SVB’s financial ratings. The next day, Thursday, March 9, the financial downgrade caused the price of its holding company’s publicly traded shares to decline.
The Thursday stock price decline spooked many of the bank’s depositors, and during the day on Thursday there was in effect a run on the bank. According to the Wall Street Journal (here), bank customers “tried to withdraw $42 billion — about a quarter of the bank’s total deposits — on Thursday alone.” The flood of withdrawals “destroyed the bank’s finances”; at the close of business on Thursday, the bank, according to the Journal, had a negative cash balance of nearly $1 billion. The bank’s management scrambled to try to arrange for additional financing, but on Friday morning the California banking regulators closed the bank and the FDIC took over as receiver.
In its press release about the receivership, the FDIC said that to protect insured depositors, the agency created the Deposit Insurance National Bank of Santa Clara (DINB). The FDIC as receiver transferred to the DINB all of SVB’s insured deposits. The press release said that all insured depositors will have full access to their deposits no later than Monday, March 13, 2023. (Under the FDIC’s banking insurance scheme, bank deposits are insured up to $250,000 for all accounts the depositor holds at a single banking institution.)
The press release goes on to say that the agency as receiver will “pay uninsured depositors an advance dividend with the next week,” adding that uninsured depositors “will receive a receivership certificate for the remaining amount of their uninsured funds.” As the FDIC sells the assets of SVB, “future dividend payments may be made to the uninsured depositors.” In other words, depositors, including many small businesses and start-up companies, may not have access to their funds in excess of the insurance limit for some time to come.
The SVB failure is the second-largest bank failure in U.S. history, exceeded only by the September 2008 failure of Washington Mutual. (At the time of its closure, Washington Mutual had assets of $307 billion.) The closure of SVB is the first bank failure in the U.S. since October 2020, when regulators closed Almena State Bank in Almena, Kansas. For those who are interested, the FDIC maintains a list of failed banks on its website, here. (Just as an aside, it has been quite a number of years since I have had occasion to link on this site to the FDIC’s failed bank list).
While it has been about two and a half years since a U.S. bank has failed, SVB’s closure comes close on the heels after the announcement earlier last week that the crypto bank Silvergate was winding down operations and voluntarily liquidating. The two developments had widely divergent causes but taken together they do suggest that there are some significant stresses in the financial system, stresses that may have significant implications for other individual institutions even if not for the banking system as a whole.
We can all hope that the failure of SVB is a one-off event, but even if it does prove to be singular development, the mere fact of the failure of a bank has an ominous ring for those of us in the D&O insurance industry with a long memory. It has been several years now, but just the same it really wasn’t that long ago that we were working our way through the wave of bank failures that followed the global financial crisis; between 2008 and 2015, more than 500 federally insured banks failed. And even more distantly, there was the wave of banking institution failures during the S&L crisis in the mid-to-late 80s and early 90s.
For those of us who can remember those early bank failure waves there is the accompanying memory that the bank failures during those prior eras were accompanied by a surge in D&O claims against the former executives of the failed institutions. Many of these claims were brought by the FDIC itself in its role as receiver for the failed banks. During the bank failure wave, there were also a significant number of securities class action lawsuits filed against executives of banks that were publicly traded at the time their banks failed. I don’t know whether or not there will be any claims filed involving the failed SVB, time will tell, of course, but the possibility of a D&O claim is definitely one of the tools in the FDIC’s receivership tool kit. The bank’s investors may well be scrutinizing the bank’s statements in the lead up to the closure as well.
There is one aspect of SVB’s closure that is worth considering. As described above, a significant part of the pressure on the bank was due to rising interest rates. The rising interest rates caused the value of its bond investments to decline in value, which in turn generated losses when the bank had to liquidate investments to meet depositor withdrawal demands. Readers will recall that in my recent round-up of the top D&O stories of 2022, I identified rising interest rates as one of several macroeconomic factors that not only could undermine companies’ business operations and financial results, but that could also in turn lead to D&O claims. The sequence of events at SVB illustrates one of the ways that rising interest rates can undercut a company’s operations and even financial stability.
At least as of now, it seems likely that the Fed will continue to raise interest rates this year, creating further rate-related stress on many businesses – not just companies like SVB that have an interest rate-sensitive investment portfolio, but also the many companies that loaded up on debt during the extended low interest rate environment in recent years and that now have to refinance the low cost debt at higher rates, adding significant expense and undermining the companies’ financial performance.
What happened at SVB happened because of circumstances that were very specific to the bank. The bank’s failure may not mean that other failures are coming. But the bank’s closure is creating a great deal of stress for companies that had deposits at SVB. In trying to understand the implications of SVB’s failure, the stress and disruption for the other companies that had funds deposited at SVB could prove to be the most significant aspect of this situation.
The TV streaming company Roku disclosed in a filing Friday that of the company’s $1.9 billion in cash assets, $487 million are on deposit at SVB. Social media sites were buzzing over the weekend with rumors about other companies with significant cash deposits at the bank. The sudden and unexpected unavailability of cash has put many companies in a difficult spot. Reports on social media suggest some companies have had trouble or will have trouble making payroll. An online story on the Journal’s website over the weekend reported that VC firms and others are floating or arranging short term financing for their portfolio companies. Even if the SVB failure does not foreshadow other bank failures, there are going to be ripples from this development, ripples that will continue to play out over the next few days — and perhaps weeks and months.
There is much to worry about here, but the thing about this situation that troubles me the most was the speed of SVB’s decline. Though the causes of the failure may have been building for some time, the bank ultimate failure happened in about 36 hours. Financial markets are likely to be watchful and wary. Many will be wondering who might be next.
Can Corporate Executives be Held Personally Liable for Unpaid Wages?: There is one more thing I want to raise here, in order to put something to rest. Over the weekend, I did get a question about whether the corporate executives at the companies struggling to meet payroll because the company’s cash is tied up at SVB could be held personally liable for unpaid wages.
To be sure, as I discussed in a blog post at the time, in July 2022, an intermediate appellate court in California held, applying California law and under the circumstances of the case before the court, that a corporate officer could be held personally liable for unpaid wages.
However, in holding that the defendant company’s sole executive could be held liable for the unpaid wages, the appellate court reasoned that a person can be deemed to have “caused” a California Labor Code violation through personal involvement in the violation or through having “sufficient participation in the activities of the employer, including, for example, over those responsible for the alleged wage and hour violations, such that the [individual] may be deemed to have contributed to, and thus for purposes of this statute, caused a violation.” That is, the basis of liability was the corporate officer’s personal involvement in the failure to pay wages such that the individual “caused” the violation.
I am not a California practitioner, but based on my reading of this case, I would not expect that executives at companies that are unable to make payroll because the companies’ cash is tied up at SVB could be held liable because they have not “caused” a violation. I emphasize this here because people were asking me the question this weekend and I wanted to share my thoughts on the subject.